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Watch the BDCs

I have noticed several articles lately about business development companies starting to show stress from bad debt. I have had concerns about this since the 1st interest rate hike from the Fed. It only makes sense that BDCs would start to show stress—they already lend at very high interest rates which is to a large degree floating rate debt meaning that the smaller companies that they lend to have generally seen rising debt service costs.

Recently there was a Seeking Alpha article on some Moodys credit rating moves (or at least potential moves) placing some BDCs on negative credit outlook–not downgrading yet, but seeing signs of higher loan losses, etc.

I am interested because I hold baby bonds issued by 4 different business development companies which can be seen in my laundry list.

Here is an article in chief investment officer magazine. Here is another in Seeking Alpha. Here is one more in Private Debt Investor.

The question of course is will this worsen? Almost without a doubt. Am I concerned? Yes, I am a bit concerned, but not at a point where ‘action’ is necessary–BUT I will need to keep a close eye on information being released from the companies.

22 thoughts on “Watch the BDCs”

  1. No BDC in history has defaulted on debt. Ever, in about 25 years of the industry. With 150% required asset coverage, loan losses would have to be at least 33% of the portfolio for assets to equal debt 1 to 1. Even in the worst market periods, default rates for the worst BDC was in the ~10-12% range. BDC can raise capital by issuing stock, or letting the portfolio run off and repaying debt. Chances of a default for any of these large cap BDCs, frankly even the lowest quality BDC, is very very low.

    1. Larry, when people panic and sell you could have a large capitol loss until the market recovered. Also if they cut or suspended the dividend that could add to your loss.

      1. Bonds are not subject to risk of suspended dividend, this is interest expense which the BDC must pay otherwise they default. Bond prices can certainly fall for a period of time, but price movement for bonds is much tighter typically, and if held to maturity it does not really matter. These risks certainly apply to the stock, which is a totally different animal.

  2. I have had ARCC and TSLX common for 7+ years and have made a ton of interest income plus some capital appreciation since then (both I paid about $16-$17/share. Even with that said, I stopped DRIPing them about a year ago and even sold ITM covered calls against my positions as a hedge. I am not terribly worried about them at this point but much more cautious. If they get called away, I will decide where those funds might go (June expiry on the options).

    I also own some bonds in MAIN and BBDC but fairly small positions…

    1. Yazzer, my only BDC position (just not an area of investing interest) is a base position in the Barings 2029 senior unsecured. No personal interest in feigning worry about this one.

    2. I took a que from your comment and sold some calls against my ARCC holding. Been wanting to do it for a while now, especially with the stock at the top of its range and chatter about BDCs rising.

      1. Nice – about half of mine are the $20 strike and the other half, the $21. I have some odd-ball shares (something a bit less than 200 spread over 3 accts that I could not sell against). But, my position in ARCC has grown a LOT over the years to almost 2000 shares which is way more than I normally hold ($-wise) in my accounts on any one position. Hence the hedging. TSLX is only about a third of that position in dollars.

        I don’t think either of them would ever default as both have excellent mgmt teams but, they could fall back in share price so equity in $$$ amount of the holdings could suffer.

  3. Good news is that you are in the bonds and you are diversified. The bad news is with all these so-called provate credit funds out there underwriting standards must be dropping as well.

    1. Gee, I wonder what the ‘underwriting standards’ were like at Republic First which was seized by bank regulators Friday night. 🤔 Of course BDCs don’t have access to public bailouts so they will live and die by how carefully they invest…ymmv

      1. hi Citadel

        Not 100% I understand the comparison. From what I saw it was not bad loans that caused the issue at Republic First but rather a bank run coupled with a below water portfolio of low coupon Agency bonds and mortgage securities. Why these banks didn’t bother hedging their interest rate risk I will never understand, but evidently selling Treasurty Futures before the Fed started to raise rates is too complex to an unertaking for the average banker.

        The issue pointed out with BDCs is one of credit risk. BDCs target risky borrowers in the midcap space. So it’s not a shocker when they get come under pressure due to rate increases. Good news is that BDCs don’t have deposit flight risk, and can issue more stock pretty easily. In the case of Midcap their Sr secured loan does not start to get paid down till 2027. So as long as they don’t trip the covenants on that loan, then their won’t be a rug pull causing them to fail.

        It does make sense to keep a careful eye on increases in PIK income and the Total Assets/Debt ratio for firms like Midcap. Tracking price/book also makes a lot of sense. Deterioration in any of these metrics could be an early warning sign. The other thing that could happen is sooner or later there might be a “short seller” report in the BDC space that would get everybody excited and drive up volatility.

        1. Where on earth did you get the notion there was a bank run at Republic First? The FDIC seized then sold RF’s assets to Fulton Bank precisely to prevent such an occurrence. As far as the quality of the loan portfolio, we won’t know how good or bad it was until Fulton Bank reports on it, although a presentation given by Republic First last July indicated the mortgage portfolio had “declined substantially in a rising rate environment.”

          I realize the nature of these chat forums is that some folks use it to pontificate more than others, but please try not to insert your own set of ‘facts’ into the story.

            1. In this article is a link to a preso dated 7/23
              Point your pontification detector to slide 8 and note the term agency securities in the pie chart. So there is that.

              You don’t like my posts? Don’t read them.

            2. Just to clarify…there was no bank run at Republic First and the Forbes article you linked does not cite it as a reason for the bank’s collapse.

              bank run
              The concerted action of depositors who try to withdraw their money from a bank because they think it will fail.

          1. Citadel

            If you are seriously able to read that that article and conclude that a decline in bank deposits was not a contributing factor and a partial cause of failure of this bank then I do not know what planet you are living on.

            If you want to argue that this situation does not meet a canonical definition of a bank run, then I would say you are arguing semantics.

            If you further wish to accuse me of making up facts and pontification based on your analysis of this artice and comparison to bank run definition, then I also suppose that is your right.

            Yes this situation as documented in the artice (obviously) meets the definition you have posted.

            If you want to say that the declining deposits at this bank was not a bank run and did not contribute to the failure, then that is your perogative. But such a conclusion is not consistent with available facts.

            In any event, the point I was making was to differentiate BDC vehicles from banks on the basis of potential of deposit flight. This is still valid, and your statements have done nothing (at all) to refute this point.

            With that I will end this discussion, and not engage further with you on any other topic.

            1. Here’s what Steve Kelly, director of Yale School of Management’s Program on Financial Stability told Bloomberg on Friday regarding the FDIC’s action.

              “This was as it should be, in the sense that the regulators were able to seize and sell all of a weak bank to a substantially more stable bank. That helps preserve the value of the deposit franchise — and thus avoid the unrealized losses and a run on the bank.”


              Now I happen to disagree that FDIC intervention was needed to save a small poorly run regional bank, and would have preferred that there were an actual bank run on Republic First which caused its failure, but that in fact did NOT happen and no one with a fundamental understanding of the situation thinks it does.

              As for BDCs, I think someone else pointed out their extremely low failure rate and high coverage ratios compared to banks, to which I would add that unlike banks BDCs must operate without the safety net of federal intervention and the moral hazard associated therein.

              -btw good luck to you with your SACH short and I look forward to reading about your ongoing ‘concerns’ with the performance of that company in the future. 😉

    1. One thing I have noticed over the years is that new start ups coming out of an economic downturn seem to do better than older established companies that have had time to take on more debt and accumulate more losses. Not saying we are coming out of an economic downturn, just thinking a newer company with less baggage might do better. Noticed recently one such company is Blue Owl capitol OBDC

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